While tariffs no longer monopolize the headlines, investor uncertainty still remains and continues to heavily influence the U.S. and global equity markets. On top of the tariff situation of recent weeks, the current U.S. administration's public pressure on the Federal Reserve is furthering this uncertainty and pushing some investors away from the U.S. dollar and government bonds.
In this week's economic update, we are examining the repercussions felt in the wake of the on-going (and often erratic) U.S. tariff situation and the situation surrounding the Federal Reserve. Specifically, we are looking at the weakening of U.S. government bonds and the U.S. dollar - both often beneficiaries of economic uncertainty and market stress - and what this could indicate for the markets moving forward.
We are also sharing the latest publication from RBC Economics, which previews March's preliminary retail and manufacturing sales and what this can tell us about the impact of the U.S. tariffs on the Canadian economy.
Economic Update
What a difference a few weeks, or even days, makes.
In a major pivot, the U.S. administration went from proposing sweeping tariffs across many of its trading partners to then extending a three-month reprieve for all countries. The exception is China, where tariffs have since risen meaningfully. Previously announced tariffs impacting the auto sector, steel and aluminum remain in place, while new exemptions for some electronics have been granted.
The shift in approach has led to some respite from the big market swings experienced recently, but uncertainty remains elevated. Moreover, the “risk-off” backdrop that traditionally comes in a period of market uncertainty has turned into a “U.S.-off” environment. The term, coined recently by an interest rate strategist at RBC, refers to the simultaneous weakness seen in U.S. stocks, government bonds, and the U.S. dollar. We will explore this more in this week’s economic update.
U.S. stocks have struggled and under-performed, especially in technology
The U.S. stock market has struggled this year. The weakness has been observable across small, midsize, and “large cap” stocks. Many sectors except a few traditionally defensive ones, have also been weak. And while global stocks have had challenges too, U.S. stocks have under-performed many other developed markets.
We attribute this under-performance to a fundamental issue that tends to catch up to stock at some point: elevated valuations. The U.S. stock market entered this year at a forward Price to Earnings multiple of well over 20 times versus its historical average of closer to 16 times. Investors had come to expect strong growth from the U.S. stock market and were particularly enthralled with the earnings potential driven by capital spending tied to generative artificial intelligence. That left investors with very high expectations for future growth, which has now come into question. It is not surprising that technology-related pockets of the U.S. market have been among the weakest year-to-date.
Bond yields are something to keep an eye on.
Weakness in the stock markets is par for the course during periods of uncertainty. More surprising has been the behaviour in the U.S. government bond market in recent weeks. Bond yields tend to fall (and bond prices rise) when investors are seeking the relative safety and comfort offered by bonds, and in particular government bonds. But in and around the time of the U.S. government’s policy pivot, longer-term U.S. government bond yields rose (prices fell) relatively sharply. This suggests some investors were selling. There is no way of knowing for sure, but some of the pressure can be attributed to potential deleveraging in the institutional and hedge fund community and potential selling by foreign investors, including central banks. Bond yields have moved lower more recently suggesting this could have simply been a temporary anomaly, but it bears watching, nonetheless.
U.S. dollar weakness reflecting investor concerns
Finally, the U.S. dollar. It too has often been a beneficiary during periods of market stress. But this time around it has failed to live up to that reputation. It has been weak all year and has continued to decline during the past few weeks with other major currencies such as the Canadian dollar, euro, Japanese yen, Swiss franc, and pound sterling sitting at year-to-date highs and some even at multi-year highs relative to the U.S. dollar. The U.S. dollar weakness this year reflects investor concerns and questions that have surfaced on a number of fronts, including the trajectory of U.S. economic growth, potential for global investors to rotate out of U.S. assets, unpredictable and erratic government policy, and the sustainability of the U.S. fiscal position.
Summary
The recent volatility experienced in the U.S. markets will take some time to fade from memory, and the 90-day tariff reprieve means that future uncertainty has potentially only been ‘kicked down the road’. That said, the U.S. will always play an important role in our investment strategy because of the sheer depth of the opportunity set presented by its stock and bond markets. The risk of this uncertainty and volatility was not a surprise, and we’ve had time to plan and prepare our portfolios to weather these choppier waters. Further, these times can often create equity opportunities for those able to invest more into the markets.
With a strategy that focuses on well-managed companies positioned in the right sectors, we remain confident in our U.S. exposure playing an important role in the long-term performance of our client portfolios.
March data to give early clues about Canada’s economy under tariffs
Preliminary retail and manufacturing sales for March next week Friday will offer early, but important clues on how the Canadian economy has fared under U.S. tariffs.
In this article from RBC Economics, Nathan Janzen and Claire Fan discuss the anticipated impacts of tariffs on March's results - and why they do not believe that the current tariffs on Canada from the U.S. are severe enough to plunge the economy into a recession. You can read the full analysis by clicking here.
As always, we are available to connect with you personally. Please don’t hesitate to contact us at 519-822-2024 or elineskyschuett@rbc.com.